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Monday, January 19, 2015

CHF Pairs Volatility – a Blessing and a Curse

“It’s futile to call the trade before it happens. One can
never know beforehand if a trade is

going to be a day trade, a short term trade of days or
weeks or a long term trade of weeks up to months. Every trade develops from the
embryonic stage of the smallest form on the smallest time scale.”– Dirk Vandycke

How It Started

On September 2011, the Swiss National Bank (SNB) made a
decision to put a peg at the 1.2000 on EUR/CHF. They did so because they wanted
to stabilize the export industry and the whole economy. It meant that EUR
wasn’t allowed to reach parity with CHF, unlike other CHF pairs. That previous
support level was referred to as a great floor, and the SNB would keep on
purchasing vast amounts of Euros to preclude it from depreciating against Swiss
Francs.

In the year 2011, EURCHF was below the level 1.2000. In
fact, EURCHF plummeted by more than 2800 pips that year, reaching a low of
1.0069. After the peg was effected, the cross jumped upwards above the level
1.2000. In the year 2012, price became very weak, but it was unable to close
below the level at 1.2000. Any time price went below the level, it would jump
above the level again.

In the year 2013, price was able to trade upwards
noticeably, owing to the strength in the Euro. Price was able to move upwards
by over 500 pips, reaching a high of 1.2648. In the year 2014, price trended
downwards in a slow and steady manner until it reached the floor at 1.2000
again at the end of that year. Many saw this as a peerless opportunity to buy
EURCHF cross.

EURCHF then looked like ‘an unfair’ market in which
everybody could make money. It was like
a market in which everybody could harness huge gains, and certain lovers of
risk might be willing to risk a huge part of their portfolios. Many thought it
was stupid go short on EURCHF, since there was a “guarantee” that the cross
would eventually go up, just like interest rates in some developed countries, which
some thought had nowhere to go expect upwards. Some didn’t even know that
interest rate could be made negative. The
only thing that could render the scenario useless was when the peg was removed
– which the SNB was unwilling to do then.

January 15, 2015 –
Magnificent Earthquakes in theMarkets

Nevertheless, it was getting more and more expensive for the
SNB to defend the peg. A central bank would need a very deep pocket to keep on
doing that for a long time. The SNB reserves increased to a record high and the
outlook on Euro was becoming more and more gloomy. It was clear that holding onto
that floor was illogical. On January 15, 2015, the SNB suddenly removed the peg
and decreased the interest rate further into the negative territory. The trading
world was taken by surprise. Some traders made huge profits and losses. Only
those who didn’t trade CHF pairs weren’t seriously affected.

USDCHF dropped by 2800 pips.

EURCHF dropped by 3300 pips

GBPCHF dropped by 4300 pips

CADCHF dropped by 1500 pips

CHFJPY rallied by 6900 pips

NZDCHF dropped by 1500 pips

AUDCHF dropped by 1500 pips

These moves were unprecedented! A daily candle was as long
as a human arm! While it is normal for a pair/cross to experience a directional
movement of thousands of pips within several days, weeks or months, it’s not
normal for a pair/cross to move so much in a single day. The market is like a
rubber band, if it moves to far in one direction, you should expect it to snap
back in the opposite direction. Thus there were significant corrections on that
day alone.

Neither the SNB nor the markets can be blamed for this: a
central bank has the right to do what they want with their currency. In
addition, the markets conditions that brought losses to some are the same
conditions that brought profits for some. Good risk managers suffer negligible
loss when caught on the wrong side of the market, and they make commendable
gains when they’re caught on the right side.

Lessons for
Gamblers

I know someone who made a profit of 7,000,000 Euros in 2
hours. Someone who funded his account with 100 dollars and was using 0.1 lots
made 2600% returns in a single day. Someone who funded his account with 1000
dollars and traded with 0.5 lots came home from work and saw an account balance
of over 10,000 dollars. Many brokers now need to pay their clients gargantuan
amounts of profits.

If you made huge profits here, like several hundreds of
percentage of profits, it was only a matter of luck; and no trader can
experience permanent success based on pure luck. Good traders are those who survive adverse
market conditions, not only those who make big money from the markets.

On the other hand, many traders received margin calls or
lost most part of their portfolios. Imagine someone using 60.0 lots on a
1,000,000 pounds account. Needless to say, the money was lost immediately.
Certain brokers were badly affected (though most brokers were unaffected). I
deeply empathize with those who were badly affected.

I was also affected, for I was holding two long positions on
EURCHF and NZDCHF, but I suffered only -1.2% losses in total. My loss should be
only 1% on the 2 trades, but you know, slippage. Stops will forever be our life
insurance policy. If you follow the advice of those who don’t use stops, your
losses can’t be their responsibility.

Do you remember the May 6, 2010 Flash Crash? Do you remember
the earthquake in Japan, which occurred on March 11, 2011, plus the nuclear
disaster that followed? Do you know the effects they had on the markets? Do you
know how traders were affected and what happened following massive drops in prices?
These should serve as lessons against the Gambler’s Fallacy. Unfortunately,
many people seemed not to learn their lesson.

Overconfidence is definitely not a good thing.

As you can see, whether you trade with fundamental or
technical analysis or combine both, you don’t know what the market will do next
and you can’t be always right. Even those who prognosticated that the peg would
be removed didn’t know when exactly it would be. When things go wrong, only risk control will
help you, not your knowledge of technical or fundamental things. It’s better to
focus on what we can control – our winners and losers.

It’s not the best to sacrifice permanent success for
short-term greed. Those who appear stupid by doing the right things would
eventually be proven to be prudent.

When I recommend the risk of 0.5% per trade, most people
ignore me. In fact, you’d hardly see someone using only 0.1 lots on a $20,000
dollars account or 0.5 lots on a $100,000 dollars account. They think it’s too
illogical and conservative, playing down my warning that the safety of our
portfolios are more important that the profits we want to make. Large losses
are extremely difficult to recover and therefore, they should be avoided at all
costs. The most guaranteed setup in the
world can’t make me risk more than 0.5% on any of my future trade.

I’ve been an advocate
of permanent success, but it can’t be achieved by those who use large position
sizes.Leverage isn’t a problem, but an irrational use of leverage is
the problem. Leverage is a boon to risk managers who know how to control their
losses and profits.

Next Directions on
CHF Pairs

The SNB might still try to keep the CHF undervalued and they
may explore another means of doing so. Opportunities to go long arose when
prices decline towards ridiculously abnormal levels. These kinds of movements
in a single day are extremely spectacular, and therefore, current CHF pairs’
prices are bound to get corrected in the long run and things would return to
normal in a matter of weeks. For instance, when USDCHF dropped like a stone,
EURUSD ought to spike skywards, since they are negatively correlated in a
normal condition. The latter was not affected, and both pairs cannot remain
bearish for a long time (and Greenback is strong in its own right). USDCHF
would, therefore, move upwards by at least, 500 pips this month or next month.

These kinds of markets offer unique opportunities to assume
contrarian positions. At the end of January 15, 2015, I went long on EURCHF,
USDCHF, AUDCHF, NZDCHF, GBPCHF and CADCHF (selling short CHFJPY), using a
position size of 0.1 lots for each $20,000. I target 500 pips on each trade.
I’d hold these long positions for weeks or months – until all the targets are
met. I won’t make use of breakeven or trailing stops this time around because I
want to create enough leeway for the high volatility in the markets, while I
enjoy the free ride.

The bearish pair and crosses cannot remain bearish forever.
The CHF markets are expected to correct themselves gradually until things
become normal. As some bask in the euphoria of windfall and others lick their wound,
we shouldn’t forget the lessons we learn from the CHF pairs volatility, which
were a blessing and a curse.

This piece is ended with the quote below:

“If you trade at a size that’s nearly meaningless, there
will be very little emotions involved. However, if you are taking on big risks
you will make emotional mistakes.”–
Dave Landry